Skyward Specialty Insurance Group, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The term “Skyward Specialty” as used below refers only to Skyward Specialty Insurance Group, Inc. and the terms “our Company,” “we,” “us,” and “our” as used below refer to Skyward Specialty Insurance Group and its consolidated subsidiaries. The term “third quarter” as used below refers to the three and nine months ended September 30 for the time period then ended. Select insurance and accounting terms for Skyward Specialty are defined in the section entitled “Select Insurance and Financial Terms” included in our Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Form 10-K”). The discussion and analysis below include certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2022. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. The results of operations for the three and nine months ended September 30, 2023 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2023, or for any other future period. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report, and in conjunction with our audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2022. The accompanying condensed consolidated financial statements and related notes have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”). 33 Table of Contents Overview Founded in 2006, Skyward Specialty is a specialty insurance holding company incorporated in Delaware. We have one reportable segment through which we offer a broad array of commercial property and casualty products and solutions on a non-admitted (or E&S) and admitted basis, predominantly in the United States. We focus our business on markets that are underserved, dislocated and/or for which standard insurance coverages are insufficient or inadequate to meet the needs of businesses, including our customers and prospective customers operating in these markets. Our customers typically require highly specialized, customized underwriting solutions and claims capabilities. As such, we develop and deliver tailored insurance products and services to address each of the niche markets we serve. Each of our eight distinct underwriting divisions has dedicated underwriting leadership supported by high-quality technical staff with deep experience in their respective niches. We believe this structure and expertise allows us to serve the needs of our customers effectively and be a value-add partner to our distributors, while earning attractive risk-adjusted returns. All of our insurance company subsidiaries are group rated and have financial strength ratings of “A-” (Excellent) with positive outlook from the A.M. Best Company. Key Operating and Financial Metrics We discuss certain key metrics, described below, which provide useful information about our business and the operational factors underlying our financial performance. These metrics are generally standard among insurance companies and help to provide comparability with our peers. Net retention , expressed as a percentage, is the ratio of net written premiums to gross written premiums. Underwriting income (loss) is a non-GAAP financial measure defined as income (loss) before income taxes excluding net investment income, net realized and unrealized gains and losses on investments, impairment charges, interest expense, amortization expense and other income and expenses. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of underwriting income (loss) to net income, which is the most directly comparable financial metric prepared in accordance with GAAP. Loss and LAE ratio , expressed as a percentage, is the ratio of losses and LAE to net earned premiums. Expense ratio , expressed as a percentage, is the ratio of underwriting, acquisition and insurance expenses less commission and fee income to net earned premiums. Combined ratio is the sum of loss ratio and expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss. Adjusted loss and LAE ratio , expressed as a percentage, is a non-GAAP financial measure defined as the ratio of losses and LAE, excluding losses and LAE related to the loss portfolio transfer (“LPT”) and all development on reserves fully or partially covered by the LPT, to net earned premiums. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of adjusted loss ratio to loss ratio, which is the most directly comparable financial metric prepared in accordance with GAAP. Adjusted combined ratio is a non-GAAP financial measure defined as the sum of the adjusted loss ratio and the expense ratio. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of adjusted combined ratio to combined ratio, which is the most directly comparable financial metric prepared in accordance with GAAP. Adjusted operating income (loss) is a non-GAAP financial measure defined as net income excluding the net impact of the LPT, net realized and unrealized gains or losses on investments, goodwill impairment charges and other income and expenses. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of adjusted operating income (loss) to net income (loss), which is the most directly comparable financial metric prepared in accordance with GAAP. Return on equity is annualized net income as a percentage of average beginning and ending stockholders’ equity. Adjusted return on equity is a non-GAAP financial measure defined as annualized adjusted operating income as a percentage of average beginning and ending stockholders’ equity during the applicable period. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of adjusted return on equity to return on equity, which is the most directly comparable financial metric prepared in accordance with GAAP. Tangible stockholders’ equity is a non-GAAP financial measure defined as stockholders’ equity less goodwill and intangible assets. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of tangible stockholders’ equity to stockholders’ equity, which is the most directly comparable financial metric prepared in accordance with GAAP. 34 Table of Contents Return on tangible equity is a non-GAAP financial measure defined as annualized net income as a percentage of average beginning and ending tangible stockholders’ equity during the applicable period. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of return on tangible equity to return on equity, which is the most comparable financial metric prepared in accordance with GAAP. Adjusted return on tangible equity is a non-GAAP financial measure defined as annualized adjusted operating income as a percentage of average beginning and ending tangible stockholders’ equity during the applicable period. Results of Operations The following table summarizes our results for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, Nine months ended September 30, ($ in thousands) 2023 2022 2023 2022 Gross written premiums $ 355,732 $ 270,250 $ 1,138,224 $ 879,119 Ceded written premiums (75,036) (98,795) (441,650) (383,532) Net written premiums $ 280,696 $ 171,455 $ 696,574 $ 495,587 Net earned premiums $ 227,033 $ 158,048 $ 604,211 $ 445,851 Commission and fee income 2,085 1,362 5,817 3,652 Losses and LAE 138,536 111,746 377,841 293,536 Underwriting, acquisition and insurance expenses 68,315 47,340 176,653 132,258 Underwriting income (1) $ 22,267 $ 324 $ 55,534 $ 23,709 Net investment income $ 13,089 $ 5,988 $ 26,318 $ 31,667 Net investment (losses) gains $ (2,984) $ (7,305) $ 3,328 $ (26,117) Income (loss) before income taxes $ 27,795 $ (3,118) $ 72,533 $ 23,819 Net income (loss) $ 21,711 $ (2,399) $ 56,719 $ 18,977 Adjusted operating income (1) $ 25,029 $ 10,696 $ 56,532 $ 46,934 Loss and LAE ratio 61.0 % 70.7 % 62.5 % 65.9 % Expense ratio 29.2 % 29.1 % 28.3 % 28.8 % Combined ratio 90.2 % 99.8 % 90.8 % 94.7 % Adjusted loss and LAE ratio (1) 61.1 % 64.8 % 62.7 % 63.8 % Expense ratio 29.2 % 29.1 % 28.3 % 28.8 % Adjusted combined ratio (1) 90.3 % 93.9 % 91.0 % 92.6 % Annualized return on equity 16.4 % (2.3) % 15.8 % 6.1 % Annualized return on tangible equity (1) 19.7 % (3.0) % 19.4 % 7.9 % Annualized adjusted return on equity (1) 18.9 % 10.4 % 15.8 % 15.2 % Annualized adjusted return on tangible equity (1) 22.8 % 13.4 % 19.4 % 19.4 % (1) See “Reconciliation of Non-GAAP Financial Measures” in this Item 2 35 Table of Contents Reconciliation of Non-GAAP Financial Measures Adjusted Operating Income (Loss) The following table provides a reconciliation of adjusted operating income to net income for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, Nine months ended September 30, 2023 2022 2023 2022 ($ in thousands) Pre-tax After-tax Pre-tax After-tax Pre-tax After-tax Pre-tax After-tax Income (loss) as reported $ 27,795 $ 21,711 $ (3,118) $ (2,399) $ 72,533 $ 56,719 $ 23,819 $ 18,977 Add: Other expenses 1,482 1,171 — — 4,061 3,208 — — Less: Net impact of loss portfolio transfer 266 210 (9,271) (7,324) 970 766 (9,271) (7,324) Net investment (losses) gains (2,984) (2,357) (7,305) (5,771) 3,328 2,629 (26,117) (20,633) Adjusted operating income $ 31,995 $ 25,029 $ 13,458 10,696 $ 72,296 $ 56,532 $ 59,207 $ 46,934 Underwriting Income (Loss) The following table provides a reconciliation of underwriting income (loss) to income (loss) before federal income tax for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, Nine months ended September 30, ($ in thousands) 2023 2022 2023 2022 Income (loss) before federal income tax expense (benefit) $ 27,795 $ (3,118) $ 72,533 $ 23,819 Add: Interest expense 2,632 1,738 7,250 4,280 Amortization expense 463 387 1,336 1,160 Other expenses 1,482 — 4,061 — Less: Net investment income 13,089 5,988 26,318 31,667 Net investment (losses) gains (2,984) (7,305) 3,328 (26,117) Underwriting income $ 22,267 $ 324 $ 55,534 $ 23,709 36 Table of Contents Adjusted Loss Ratio / Adjusted Combined Ratio The following table provides a reconciliation of the adjusted loss and LAE ratio and adjusted combined ratio to the loss and LAE ratio and combined ratio for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, Nine months ended September 30, ($ in thousands) 2023 2022 2023 2022 Net earned premiums $ 227,033 $ 158,048 $ 604,211 $ 445,851 Losses and LAE 138,536 111,746 377,841 293,536 Pre-tax net impact of loss portfolio transfer (266) 9,271 (970) 9,271 Adjusted losses and LAE $ 138,802 $ 102,475 $ 378,811 $ 284,265 Loss ratio 61.0 % 70.7% 62.5 % 65.9 % Net impact of LPT (0.1) % 5.9% (0.2) % 2.1% Adjusted Loss Ratio 61.1 % 64.8 % 62.7 % 63.8 % Combined ratio 90.2 % 99.8 % 90.8 % 94.7 % Less: Net impact of LPT (0.1) % 5.9% (0.2) % 2.1% Adjusted Combined Ratio 90.3 % 93.9 % 91.0 % 92.6 % Tangible Stockholders’ Equity The following table provides a reconciliation of tangible stockholders’ equity to stockholders’ equity for the periods ended September 30, 2023 and 2022: ($ in thousands) 2023 2022 Stockholders' equity $ 535,397 $ 399,817 Less: Goodwill and intangible assets 88,808 90,237 Tangible stockholders' equity $ 446,589 $ 309,580 Adjusted Return on Equity The following table provides a reconciliation of annualized adjusted return on equity to annualized return on equity for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, Nine months ended September 30, ($ in thousands) 2023 2022 2023 2022 Numerator: annualized adjusted operating income $ 100,116 $ 42,784 $ 75,376 $ 62,579 Denominator: average stockholders’ equity $ 529,038 $ 409,712 $ 478,530 $ 412,949 Annualized adjusted return on equity 18.9 % 10.4 % 15.8 % 15.2 % Return on Tangible Equity Annualized return on tangible equity for the three and nine months ended September 30, 2023 and 2022 reconciles to annualized return on equity as follows: Three months ended September 30, Nine months ended September 30, ($ in thousands) 2023 2022 2023 2022 Numerator: annualized net income $ 86,844 $ (9,596) $ 75,625 $ 25,303 Denominator: average tangible stockholders’ equity $ 440,043 $ 319,292 $ 389,191 $ 322,162 Annualized return on tangible equity 19.7 % (3.0) % 19.4 % 7.9 % 37 Table of Contents Adjusted Return on Tangible Equity Annualized adjusted return on tangible equity for the three and nine months ended September 30, 2023 and 2022 reconciles to annualized return on equity as follows: Three months ended September 30, Nine months ended September 30, ($ in thousands) 2023 2022 2023 2022 Numerator: annualized adjusted operating income $ 100,116 $ 42,784 $ 75,376 $ 62,579 Denominator: average tangible stockholders’ equity $ 440,043 $ 319,292 $ 389,191 $ 322,162 Annualized adjusted return on tangible equity 22.8 % 13.4 % 19.4 % 19.4 % Underwriting Results Premiums The following tables presents gross written premiums by underwriting division for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, ($ in thousands) 2023 2022 Change % Change Global Property & Agriculture $ 48,775 $ 40,808 $ 7,967 19.5 % Industry Solutions 79,798 64,866 14,932 23.0 % Programs 41,735 37,239 4,496 12.1 % Captives 41,886 27,413 14,473 52.8 % Professional Lines 48,259 27,215 21,044 77.3 % Accident & Health 39,554 33,368 6,186 18.5 % Transactional E&S 30,699 21,311 9,388 44.1 % Surety 24,977 18,206 6,771 37.2 % Total continuing business $ 355,683 $ 270,426 $ 85,257 31.5 % Exited business 49 (176) 225 N/M (1) Total gross written premiums $ 355,732 $ 270,250 $ 85,482 31.6 % (1) N/M = Not Meaningful Nine months ended September 30, ($ in thousands) 2023 2022 Change % Change Global Property & Agriculture $ 247,195 $ 177,565 $ 69,630 39.2 % Industry Solutions 226,680 202,237 24,443 12.1 % Programs 143,032 131,752 11,280 8.6 % Captives 127,249 97,579 29,670 30.4 % Professional Lines 114,420 62,127 52,293 84.2 % Accident & Health 112,819 97,107 15,712 16.2 % Transactional E&S 90,948 52,645 38,303 72.8 % Surety 75,899 53,734 22,165 41.2 % Total continuing business $ 1,138,242 $ 874,746 $ 263,496 30.1 % Exited business (18) 4,373 (4,391) N/M (1) Total gross written premiums $ 1,138,224 $ 879,119 $ 259,105 29.5 % (1) N/M = Not Meaningful 38 Table of Contents The increase in gross written premiums for the third quarter of 2023, when compared to the same 2022 period, was driven by double-digit premium growth from all eight of our underwriting divisions. The double-digit premium growth was due to (i) new business across all of our underwriting divisions, and (ii) increased rates, primarily in industry solutions, captives and transactional E&S. The increase in gross written premiums for the first nine months of 2023, when compared to the same 2022 period, was primarily driven by double-digit premium growth in our professional lines, transactional E&S, global property and agriculture, surety and captives underwriting divisions. The gross written premium increases were primarily driven by new business and rate increases. During the first nine months of 2023, we added new teams and products in our surety, captives, professional lines and global property and agriculture underwriting divisions. Net written premiums for the third quarter of 2023 were $280.7 million, an increase of $109.2 million, or 63.7%, when compared to the same 2022 period. Net written premiums for the nine months ended September 30, 2023 were $696.6 million, an increase of $201.0 million or 40.6%. During the third quarter of 2023, the Company rescinded a quota share reinsurance contract, the impact of which increased net written premiums by $50.5 million, respectively, for the third quarter and first nine months of 2023, that had previously been ceded under the contract through the first six months of 2023. Net earned premiums for the third quarter of 2023 were $227.0 million, an increase of $69.0 million, or 43.6%, when compared to the same 2022 period. Net earned premiums for the nine months ended September 30, 2023 were $604.2 million, an increase of $158.3 million, or 35.5%, when compared to the same 2022 period. The increases in net earned premiums were primarily driven by the same reasons that drove the increases in gross written premiums discussed above. Net earned premiums for the third quarter and first nine months of 2023 were also impacted by the Company’s decision to rescind a quota share reinsurance contract, the impact of which increased net earned premiums by $13.1 million, respectively, that had previously been ceded under the contract through the first six months of 2023. For additional information regarding our reinsurance programs, see the “Reinsurance” discussion included in this Item 2 . 39 Table of Contents Losses and LAE The following tables set forth the components of the loss and LAE ratios and adjusted loss and LAE ratios for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, 2023 2022 ($ in thousands) Losses and LAE % of Net Earned Premiums Losses and LAE % of Net Earned Premiums Losses and LAE: Non-cat loss and LAE (1) $ 137,802 60.7 % $ 97,975 62.0 % Cat loss and LAE (1) 1,000 0.4 % 4,500 2.8 % Prior accident year development - LPT (266) (0.1) % 9,271 5.9% Total losses and LAE $ 138,536 61.0 % $ 111,746 70.7 % Adjusted losses and LAE (2) : Non-cat loss and LAE (1) $ 137,802 60.7 % $ 97,975 62.0 % Cat loss and LAE (1) 1,000 0.4 % 4,500 2.8 % Total adjusted losses and LAE (2) $ 138,802 61.1 % $ 102,475 64.8 % (1) Current accident year (2) See "Reconciliation of Non-GAAP Financial Measures" included in this Item 2 Nine months ended September 30, 2023 2022 ($ in thousands) Losses and LAE % of Net Earned Premiums Losses and LAE % of Net Earned Premiums Losses and LAE: Non-cat loss and LAE (1) $ 367,767 60.9 % $ 279,765 62.8 % Cat loss and LAE (1) 11,044 1.8 % 4,500 1.0 % Prior accident year development - LPT (970) (0.2) % 9,271 2.1% Total losses and LAE $ 377,841 62.5 % $ 293,536 65.9 % Adjusted losses and LAE (2) : Non-cat loss and LAE (1) $ 367,767 60.9 % $ 279,765 62.8 % Cat loss and LAE (1) 11,044 1.8 % 4,500 1.0 % Total adjusted losses and LAE (2) $ 378,811 62.7 % $ 284,265 63.8 % (1) Current accident year (2) See "Reconciliation of Non-GAAP Financial Measures" included in this Item 2 The loss ratio for the third quarter of 2023 improved 9.7 points when compared to the same 2022 period. The non-cat loss and LAE ratio improved 1.3 points when compared to the same 2022 period, primarily driven by the shift in the mix of business and continued run-off of exited business. Catastrophe losses only added 0.4 points to the current quarter loss ratio compared to the third quarter of 2022, which was impacted by 2.8 points of catastrophe losses from Hurricane Ian. The third quarter of 2022 was impacted by strengthening LPT reserves by $14.4 million partially offset by reinsurance recoveries of $5.1 million, which added 5.9 points to the 2022 loss ratio. The loss ratio for the first nine months of 2023 improved 3.4 points when compared to the same 2022 period. The non-cat loss and LAE ratio improved 1.9 points when compared to the same 2022 period, primarily driven by the shift in the mix of business and continued run-off of exited business. Catastrophe losses from second and third quarter convective storms and first quarter wind and hail events, including tornadoes, added 1.8 points to the loss ratio compared to the first nine months of 2022, which was impacted by 1.0 point of catastrophe losses from Hurricane Ian. The loss ratio for the first nine months of 2022 included 2.1 points from the net impact of LPT reserve strengthening. 40 Table of Contents Expense Ratio The following tables set forth the components of the expense ratios for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, 2023 2022 ($ in thousands) Expenses % of Net Earned Premiums Expenses % of Net Earned Premiums Net policy acquisition expenses $ 34,071 15.0 % $ 17,379 11.0 % Other operating and general expenses 34,244 15.1 % 29,961 19.0 % Underwriting, acquisition and insurance expenses 68,315 30.1 % 47,340 30.0 % Less: commission and fee income (2,085) (0.9 %) (1,362) (0.9 %) Total net expenses $ 66,230 29.2 % $ 45,978 29.1 % Nine months ended September 30, 2023 2022 ($ in thousands) Expenses % of Net Earned Premiums Expenses % of Net Earned Premiums Net policy acquisition expenses $ 78,442 13.0 % $ 45,514 10.2 % Other operating and general expenses 98,211 16.3 % 86,744 19.5 % Underwriting, acquisition and insurance expenses 176,653 29.3 % 132,258 29.7 % Less: commission and fee income (5,817) (1.0 %) (3,652) (0.9 %) Total net expenses $ 170,836 28.3 % $ 128,606 28.8 % The expense ratios for the third quarter and first nine months of 2023 increased slightly and improved 0.5 points, respectively, when compared to the same 2022 periods. The increase in the net policy acquisition cost ratios for the third quarter and first nine months of 2023, when compared to the same 2022 periods, was primarily driven by the (i) shift in the mix of business, and (ii) impact of the cancellation of the quota share reinsurance contract. The improvement in the other operating and general expenses ratios for the third quarter and first nine months of 2023, when compared to the same 2022 periods, was primarily due to the increase in earned premiums. The expense ratios for the third quarter and first nine months of 2023 exclude the impact of IPO related stock compensation and secondary offering expenses, which are reported in other expenses in our condensed consolidated statements of operations and comprehensive income (loss). 41 Table of Contents Investment Results The following tables set forth the components of net investment income and net investment gains (losses) for the three and nine months ended September 30, 2023 and 2022: Three months ended September 30, Nine months ended September 30, $ in thousands 2023 2022 2023 2022 Short-term and money market investments $ 3,148 $ 496 $ 8,070 $ 631 Core fixed income 8,549 4,682 21,855 10,637 Opportunistic fixed income (47) 632 (5,617) 19,106 Equities 1,438 171 2,007 1,279 Net investment income (1) $ 13,088 $ 5,981 $ 26,315 $ 31,653 Net unrealized (losses) gains on securities still held $ (6,391) $ (6,297) $ 2,394 $ (26,180) Net realized gains (losses) 3,407 (1,008) 934 63 Net investment (losses) gains $ (2,984) $ (7,305) $ 3,328 $ (26,117) (1) excludes income from operating cash for the third quarter and first nine months ended September, 30, 2023 and 2022. Net investment income for the third quarter and first nine months of 2023 increased $7.1 million and decreased $5.3 million, respectively, when compared to the same 2022 periods. The increase in income from our core fixed income portfolio for the third quarter and first nine months of 2023, when compared to the same 2022 periods, was due to (i) a larger asset base as we continued to increase our allocation to this part of our investment portfolio and (ii) a higher book yield of 4.2% at September 30, 2023 compared to 3.3% at September 30, 2022. The increase in income from short-term and money market investments for the third quarter and first nine months of 2023, when compared to the same 2022 periods, was due to a larger asset base and higher investment yields when compared to the same 2022 periods. The opportunistic fixed income portfolio was impacted by a decline in the fair value of limited partnership investments for the third quarter and first nine months of 2023 when compared to the same 2022 periods. When a fixed maturity has been determined to have an impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings as a realized loss and on the balance sheet as an allowance for credit losses netted with the amortized cost of fixed maturities. Future increases in fair value, if related to credit factors, are recognized through earnings limited to the amount previously recognized as an allowance for credit losses. The amount related to non-credit factors is recognized in accumulated other comprehensive income and future increases or decreases in fair value, if not credit losses, are included in accumulated other comprehensive (loss) income. We reviewed our available-for-sale fixed maturities at September 30, 2023 and determined that no credit impairment existed in the gross unrealized holding losses. See Note 2, “Investments” to our condensed consolidated financial statements included in Item 1 of this Form 10-Q for additional information.   Investments Composition of Investment Portfolio The following table sets forth the components of our investment portfolio at carrying value at September 30, 2023 and December 31, 2022: 2023 2022 ($ in thousands) Fair Value % of Total Fair Value % of Total Short-term and money market investments $ 194,844 14.0 % $ 121,268 11.2 % Core fixed income 874,864 62.7 % 607,572 56.1 % Opportunistic fixed income 182,533 13.0 % 196,021 18.1 % Equities 143,637 10.3 % 157,506 14.6 % Total investment portfolio $ 1,395,878 100.0 % $ 1,082,367 100.0 % 42 Table of Contents Core fixed income The core fixed income portfolio consists primarily of investment grade fixed income securities which are predominantly highly-rated and liquid bonds. Our objective is to earn attractive risk-adjusted returns with a low risk of loss of principal. The portfolio is managed by third party managers. The average duration of the portfolio was approximately 4.4 years and 4.3 years, respectively, as of September 30, 2023 and December 31, 2022. The following table sets forth the components of our core fixed income portfolio at September 30, 2023 and December 31, 2022: 2023 2022 ($ in thousands) Fair Value % of Total Fair Value % of Total U.S. government securities $ 46,382 5.3 % $ 48,541 8.0 % Corporate securities and miscellaneous 333,009 38.1 % 235,129 38.7 % Municipal securities 83,367 9.5 % 57,727 9.5 % Residential mortgage-backed securities 230,698 26.4 % 119,856 19.7 % Commercial mortgage-backed securities 17,671 2.0 % 36,495 6.0 % Asset-backed securities 163,737 18.7 % 109,824 18.1 % Core fixed income securities, available-for-sale $ 874,864 100.0 % $ 607,572 100.0 % The weighted average credit rating of the portfolio was “AA-” by Standard & Poor’s Financial Services, LLC (“Standard & Poor’s”) at September 30, 2023 and “AA” by Standard & Poor’s at December 31, 2022. The following table sets forth the credit quality of our core fixed income portfolio at September 30, 2023 and December 31, 2022, as rated by Standard & Poor’s or equivalent designation: 2023 2022 ($ in thousands) Fair Value % of Total Fair Value % of Total AAA $ 420,240 48.0 % $ 283,733 46.7 % AA 102,939 11.8 % 74,604 12.3 % A 194,438 22.2 % 134,175 22.1 % BBB 126,493 14.5 % 88,369 14.5 % BB and Lower 30,754 3.5 % 26,691 4.4 % Total core fixed income $ 874,864 100.0 % $ 607,572 100.0 % Opportunistic fixed income The opportunistic fixed income portfolio is managed by Arena which is affiliated with Westaim, our largest stockholder. The opportunistic fixed income portfolio consists of separately managed accounts, limited partnerships, promissory notes and equity interests. The underlying securities are primarily floating rate senior secured loans, comprised of short duration, collateralized, asset-oriented credit investments designed to generate attractive risk-adjusted returns. The limited partnerships are subject to future increases or decreases in asset value as asset values are monetized and the income is distributed. As of September 30, 2023, the opportunistic fixed income portfolio consisted of three components: diversified asset based lending (54.3%), commercial mortgage loans (32.5%) and cash and cash equivalents (13.2%). 43 Table of Contents The following table sets forth the components of our opportunistic fixed income portfolio by industry sector at September 30, 2023 and December 31, 2022: 2023 2022 ($ in thousands) Fair Value % of Total Fair Value % of Total Real Estate $ 96,353 52.8 % $ 90,370 46.1 % Oil & Gas 16,902 9.3 % 20,725 10.6 % Banking, Finance & Insurance 13,254 7.3 % 13,870 7.1 % Other sectors (1) 31,943 17.4 % 34,072 17.4 % Cash and cash equivalents (2) 24,081 13.2 % 36,984 18.8 % Opportunistic fixed income $ 182,533 100.0 % $ 196,021 100.0 % (1) Other sectors primarily includes Financial Services and Commercial & Industrial. (2) Includes cash on settlements that have not yet been reinvested. The average duration of the debt instruments in the portfolio is approximately 1.3 years and 1.4 years as of September 30, 2023 and December 31, 2022, respectively. During the third quarter of 2023, we provided Arena with notice to withdraw from our investment in the Arena Special Opportunities Fund, LP. Equities The equities portfolio primarily consists of domestic preferred stocks, common equities, exchange traded funds, limited partnerships, limited liability corporations and other types of equity interests, 74.8% of which are publicly traded. The portfolio is directed internally and includes both self-managed investments and portfolios managed by third-party investment management firms. The following table sets forth the components of our equities portfolio by security type at September 30, 2023 and December 31, 2022: 2023 2022 ($ in thousands) Fair Value % of Total Fair Value % of Total Domestic common equities $ 62,889 43.8 % $ 76,929 48.8 % International common equities 37,599 26.2 % 34,468 21.9 % Preferred stock 6,899 4.8 % 8,772 5.6 % Other (1) 36,250 25.2 % 37,337 23.7 % Equities $ 143,637 100.0 % $ 157,506 100.0 % (1) Other includes limited partnerships, limited liability companies and other equity investments in unconsolidated subsidiaries. Other Items Income Taxes Income tax expense for the three and nine months ended September 30, 2023 was $6.1 million and $15.8 million, respectively, compared to an income tax benefit of $0.7 million and income tax expense of $4.8 million, respectively, for the same 2022 periods. Our effective tax rate for the three and nine months ended September 30, 2023 was 21.9% and 21.8%, respectively, compared to 23.1% and 20.3%, respectively, for the same 2022 periods. For additional information, see Note 9 of our condensed consolidated financial statements included in Item 1 of this Form 10-Q. Liquidity and Capital Resources Sources and Uses of Funds Our most significant source of cash is from premiums received from our insureds, which, for most policies, we receive at the beginning of the coverage period, net of the related commission amount for the policies. Our most significant cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that generally earn interest and dividends. We also use cash to pay for operating expenses such as salaries, rent and taxes and capital expenditures such as technology systems. We use reinsurance to manage the risk that we take on our policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid. 44 Table of Contents The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, and as a result their timing can influence cash flows from operating activities in any given period. Management believes that cash receipts from premiums and proceeds from investment income are sufficient to cover cash outflows in the foreseeable future. Our cash flows for the nine months ended September 30, 2023 and 2022 were: ($ in thousands) 2023 2022 Cash and cash equivalents provided by (used in): Operating activities $ 218,539 $ 124,913 Investing activities (307,833) (128,281) Financing activities 67,549 2,180 Change in cash and cash equivalents and restricted cash $ (21,745) $ (1,188) The increase in cash provided by operating activities in 2023 and 2022 was primarily due to positive cash flow from our insurance operations. Cash from operations can vary from period to period due to the timing of premium receipts, claim payments and reinsurance activity. Cash flows from operations in each of the past two years were used primarily to fund investing activities. Net cash used in investing activities in 2023 and 2022 was primarily driven by purchases of fixed maturity securities and short-term investments. Net cash provided by financing activities in 2023 was primarily from proceeds of $66.3 million from our IPO. Credit Agreements Revolving Credit Facility On March 29, 2023, we entered into an unsecured revolving credit facility (the “Revolving Credit Facility”) with a syndicate of participating banks. The Revolving Credit Facility provides us with up to a $150.0 million revolving credit facility, with an accordion that can increase the capacity by $50.0 million, and a letter of credit sub-facility of up to $30.0 million. During the nine months ended September 30, 2023, we drew $50.0 million on the Revolving Credit Facility and used the proceeds to pay off the principal on our existing term loan. In connection with our entry into the Revolving Credit Facility, we terminated the existing term loan and revolving line of credit pursuant to our Credit Agreement dated as of December 11, 2019, with Prosperity Bank. Interest on the Revolving Credit Facility is payable quarterly. The interest rate on the Revolving Credit Facility is the Secured Overnight Financing Rate (“SOFR”) plus a margin of between 150 and 190 basis points based on the ratio of debt to total capital and a credit spread adjustment of 10 basis points. At September 30, 2023, the six-month SOFR on the Revolving Credit Facility was 5.47%, plus a margin of 1.60%. We are subject to covenants on the Revolving Credit Facility based on minimum net worth, maximum debt to capital ratio, minimum A.M. Best Rating and minimum liquidity. As of September 30, 2023, we are in compliance with all covenants. Trust Preferred In August 2006, we received $58.0 million of proceeds from a debenture offering through a statutory trust, Delos Capital Trust (the “Trust”). The sole asset of the Trust consists of Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Trust Preferred”) with a principal amount of $59.8 million issued by us and cash of $1.8 million from the issuance of Trust common shares purchased by us equal to 3% of the Trust capitalization. The Trust Preferred are an unsecured obligation, are redeemable, and have a maturity date of September 15, 2036. Interest on the Trust Preferred is payable quarterly at an annual rate based on the three-month LIBOR (5.66% and 4.77% at September 30, 2023 and December 31, 2022, respectively), plus 3.4%. Subordinated Debt In May 2019, we issued unsecured subordinated notes (the “Notes”) with an aggregate principal amount of $20.0 million. Interest on the subordinated notes is 7.25% fixed for the first eight years and 8.25% fixed thereafter. Early retirement of the debt ahead of the eight-year commitment requires all interest payments to be paid in full, as well as the return of all capital. Principal payment is due at maturity on May 24, 2039 and interest is payable quarterly. 45 Table of Contents At September 30, 2023 the ratio of total debt outstanding, including the Revolving Credit Facility, the Trust Preferred and the Notes, to total capitalization (defined as total debt plus stockholders’ equity) was 19.4% and at December 31, 2022, the ratio of total debt outstanding, including the Term Loan, the Revolver, the Trust Preferred and the Notes, to total capitalization was 23.4%. Reinsurance We strategically purchase reinsurance from third parties which enhances our business by protecting capital from severity events (either large single event losses or catastrophes) and reducing volatility in our earnings. Our reinsurance contracts are predominantly one year in length and renew annually throughout the year. At each annual renewal, we consider several factors that influence any changes to our reinsurance purchases, including any plans to change the underlying insurance coverage we offer, updated loss activity, the level of our capital and surplus, changes in our risk appetite and the cost and availability of reinsurance treaties. We purchase quota share reinsurance, excess of loss reinsurance, and facultative reinsurance coverage to limit our exposure from losses on any one occurrence. The mix of reinsurance purchased considers efficiency, cost, our risk appetite and specific factors of the underlying risks we underwrite. • Quota share reinsurance refers to a reinsurance contract whereby the reinsurer agrees to assume a specified percentage of the ceding company’s losses arising out of a defined class of business in exchange for a corresponding percentage of premiums, net of a ceding commission. • Excess of loss reinsurance refers to a reinsurance contract whereby the reinsurer agrees to assume all or a portion of the ceding company’s losses for an individual claim or an event in excess of a specified amount in exchange for a premium payable amount negotiated between the parties, which includes our catastrophe reinsurance program. • Facultative coverage refers to a reinsurance contract on individual risks as opposed to a group or class of business. It is used for a variety of reasons, including supplementing the limits provided by the treaty coverage or covering risks or perils excluded from treaty reinsurance. For the three and nine months ended September 30, 2023 our net retention on a written basis (calculated as net written premiums as a percentage of gross written premiums) was 78.9% and 61.2%, respectively, compared to 63.4% and 56.4%, respectively, for the same 2022 periods. Net retention for the three and nine months ended September 30, 2023 was impacted by the cancellation of a quota share reinsurance arrangement, the impact of which increased net written premiums by $50.5 million, respectively, that had previously been ceded under the contract through the first six months of 2023. The following is a summary of our reinsurance programs as of September 30, 2023: Line of Business Maximum Company Retention Accident & Health $0.88 million per occurrence Commercial Auto (1) $1.00 million per occurrence Excess Casualty (1)(2) $1.24 million per occurrence General Liability (1) $1.25 million per occurrence Professional Lines (2) $2.70 million per occurrence Property (3) $2.80 million per occurrence Surety (2) $3.00 million per occurrence Workers’ Compensation (2) $1.55 million per occurrence Cyber $2.69 million per occurrence Representation and Warranty $2.50 million per occurrence (1) Legal defense expenses can force exposure above the maximum company retention for Excess Casualty, Commercial Auto and General Liability. (2) Reinsurance is subject to a loss ratio cap or aggregate level of loss cover that exceeds a modeled 1:250-year PML event. (3) Catastrophe loss protection is purchased up to $28.0 million in excess of $12.0 million retention, which provides cover for a 1:250-year PML event. Credit and Financial Strength Ratings On August 25, 2023, A.M. Best affirmed Skyward Specialty’s financial strength rating of A- (Excellent) and revised the outlooks to positive from stable. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in market risk from the information provided in our Annual Report on Form 10-K for the year ended December 31, 2022. 46 Table of Contents